Recent Enforcement Actions

November 09, 2015

By Eric Altstadter, CPA

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SEC Charges Company and Former Executives with Accounting Fraud

The Commission recently announced that a financial services company has agreed to pay a significant amount to settle accounting fraud charges in a case that involves manipulation of the Company's financial results to meet analyst expectations.

The Commission alleges that the Company’s former CFO, former director of accounting and former vice president of finance engaged in a scheme to fabricate revenues and avoid booking certain expenses in order to meet analyst estimates for two key financial metrics: adjusted earnings per share and adjusted earnings before interest, taxes, depreciation, and amortization.

The Company allegedly overstated its second quarter net income and the Company’s stock price rose on the announcement of the inflated financial results.

According to the Commission's complaint, the Company’s CFO allegedly decided to arbitrarily increase the Company’s revenue after the end of the quarter after learning that Company’s preliminary financial results fell short of analyst estimates. Then, allegedly with the help of the director of accounting and the vice president of finance, the CFO allegedly improperly directed two of the Company’s divisions to book round dollar amounts of additional revenue without any support.

One division allegedly immediately booked the requested revenue to a dormant customer account with no intention of justifying the revenue until it was flagged by the Company's auditor. The other division resisted the CFO’s directive, but allegedly booked some improper revenue. Allegedly refusing to accept the division’s unwillingness to record the full amount of improper revenue as he directed, the CFO then directed that the approximate difference be recorded as revenue by a different business unit.

The Company also allegedly reduced certain expenses in order to meet analyst estimates. One of the expense accounts and related accrual accounts had been used as a "cushion" account to manipulate the company's financial results for at least a year.

The three executives then allegedly all lied to the Company's auditor regarding the improper accounting entries.

The Company and the vice president of finance consented to an order to cease and desist from violating the antifraud, reporting, books-and-records, and internal controls provisions of the federal securities laws. Without admitting or denying the Commission's findings, the Company agreed to pay a significant penalty and the vice president of finance also agreed to pay a significant penalty, in addition to full disgorgement of their gains from selling the Company’s stock after the false financial results were announced. The vice president of finance also agreed to be barred from serving as an officer or director at a public company for 5 years and from public company accounting for at least 5 years.

The Commission's complaint filed against the CFO and the director of accounting is ongoing and alleges they violated and/or aided and abetted the violation of the antifraud, lying-to-auditors, books-and-records, and reporting provisions of the federal securities laws. The complaint also seeks financial penalties, officer-and-director bars, and prohibitions on working in public company accounting. The complaint also seeks to recover the profits improperly obtained by when one of the executives sold his stock following the release of the inflated financial results.

The Commission charged an investment advisory firm and it’s CEO with fraudulently inflating the values of investments in the portfolio of a private fund they advised so they could illegally earn management fees. Also, the fund's outside auditors were charged by the SEC with performing a deficient audit that allowed the firm to send misleading financial statements to investors.

The investment advisory firm agreed to pay a significant amount to settle the fraud charges. The CEO and another of his advisory firms also agreed to pay a fee to settle fraud charges related to their failure to inform clients that this other advisory firm received significant fees when referring them to invest in the fund.

According to the SEC's complaint, the CEO and his advisory firm were able to withdraw net profits of the fund as compensation, which were calculated based on realized and unrealized gains and losses. They also were required to return any excess net profits to the fund as calculated by an annual audit.

The SEC also alleged that the CEO directed his advisory firm to withdraw fees that were based on fraudulently inflated investment values or were disproportionate from the fund's actual profits.

In addition, the SEC’s complaint stated that the CEO falsely claimed that the fund owned a specific bank asset that had appreciated significantly in value. Actually, the fund owned an entirely different asset that was worth materially less. As a result of the CEO’s claim, the fund's financial statements allegedly materially overstated the fund's investment values.

Finally, the SEC alleged that, in total, the CEO and the advisory firm withdrew a significant amount in fees to which they were not entitled.

Without admitting or denying the allegations, the CEO and his advisory firms agreed to the entry of an order (1) enjoining them from violations of various section of the Securities Exchange Act of 1934, of the Securities Act of 1933, and of the Investment Advisers Act of 1940; and (2) imposing disgorgement of significant earnings plus prejudgment interest and penalties, all on a joint and several basis.

The CEO also agreed to be barred from the securities industry.

In addition, the SEC settled an administrative proceeding against the fund’s external auditors alleging that they did not adhere to generally accepted auditing standards and performed a deficient audit of the fund's financial statements, which materially overstated the fund's valuation and ownership interest in certain assets and although the auditors understood that the CEO’s valuations posed a significant risk to the proper presentation of the fund's financial statements, they allegedly did not obtain sufficient appropriate audit evidence with respect to the existence of certain fund assets. Therefore, the allegation states they failed to discover that the fund did not own the assets claimed by the CEO.

The external auditors agreed to settle the charges without admitting or denying the findings and agreed to be suspended from practicing as an accountant on behalf of any publicly-traded company or other entity regulated by the SEC for a period of 3 years.

Eric Altstadter CPA is an Audit Partner with over 30 years of experience working with public companies and privately held businesses. He is the Editor-in-Charge of the firm's SEC Trends & Developments newsletter and a member of NY State Society of CPAs.

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